The Crisis of the Tax State

|Peter Boettke|

That was, of course, the title of a famous essay by Joseph Schumpeter (1918). But it also explains our lived reality. Greg Mankiw spells out the problems with current fiscal projections and policy in today's NYT:

"The troubling feature of Mr. Obama’s budget is that it fails to return the federal government to manageable budget deficits, even as the wars wind down and the economy recovers from the recession. According to the administration’s own numbers, the budget deficit under the president’s proposed policies will never fall below 3.6 percent of G.D.P. By 2020, the end of the planning horizon, it will be 4.2 percent and rising.

As a result, the government’s debts will grow faster than the economy. The administration projects that the debt-to-G.D.P. ratio will rise in each of the next 10 years. By 2020, the government’s debts will equal 77.2 percent of G.D.P. This level of indebtedness has not been seen since 1950, in the aftermath of the borrowing to finance World War II.

Making matters worse, these bleak budget projections are based on relatively optimistic economic assumptions. The administration forecasts economic growth of 3.0 percent from the fourth quarter of 2009 to the fourth quarter of 2010, followed by 4.3 percent the next year. By contrast, the Congressional Budget Office predicts growth of 2.1 percent and 2.4 percent for these two years. Lower growth would mean less tax revenue, larger budget deficits and a more rapidly increasing debt-to-G.D.P. ratio."

Well, there is always the South American approach: welch on the debts. Tell the bondholders that they're taking a big haircut, and oh-by-the-way, the government is a sovereign borrower, so your recourse is squat.

Frankly, talking up the possibility of a federal default could spook potential lenders, and drive up borrowing costs. That, in turn, could bring this problem to a head before the actual debt load gets any worse.

It will stop one way or another. But if it can't be stopped by a reasonable return to sound market principles, then I'm afraid we really don't want to experience how it will be stopped in the absence of will. The history of inflationary depressions in the world have not been pleasant.

Perhaps the few countries such as Australia and New Zealand without fiscal problems will benefit. We can't help wondering if insolvent states will take down their economies with them. Although it would seem best to screw bondholders and entitlement program beneficiaries, perhaps they'll be more tempted to productive activities leading to a flight of people and capital.

Yes, that could happen, depending on how attractive their policies are and how unattractive the policies of the countries with fiscal difficulties. Others might include Hong Kong, Singapore, Panama, Bahamas and plenty more that could be attractive. I'm considering Singapore and Brunei.

I am current reading a piece that references Schumpeter's article. Alas, I went to the stacks at my library and they only have International Economic Papers from 1955 to 1960 and they are nowhere online.

Does anyone have a copy of "The crisis of the tax state"? I would love to read it.